The multi-tiered economies of a global car market

The most tedious part of any CEO’s job, is by far the repetitive act of forecasting – you reach the role because of your knowledge, charisma and ability to deliver results but end up pretending to be Mystic Meg for most of the time.

Unless you’re shaping the future (which happens now and again), you’re responding to the changing behaviour of others (competitors, politicians, customers) and trying to guess what might happen next.

This is the situation most car company CEOs find themselves in during 2013 and it’s about to get a lot worse – but the winners will be those who remain grounded, stick to the principles that enabled their success and remain sceptical of any paths paved with gold.

What I’d like to achieve with this article, is stimulate your curiosity to look behind the headlines that shape our optimism for the future. There’s good news, but some of the claims need taken with a pinch of salt.

Has the auto industry recovered from the economic downturn? Is China the answer to everyone’s problem, or another problem in itself? And why is business booming for the likes of Porsche and Bentley, yet Renault and Honda are laying off workers?

The problems of a twin-track economy

KPMG’s UK Head of Automotive, John Leech, recently spoke of a twin-track economy where the consumer trend in mature markets is to downsize to smaller, more fuel efficient vehicles, while the reverse is true in emerging markets where buyers want larger, more upscale cars including 4x4s, sports cars and limousines.

It leads to a divergence in profitability and capital investment, often turning established forecasting models on their heads. But for how long? And how far should car makers reshape their business models around these factors?

You can partly see this when looking at Porsche, despite the affordability and world-beating abilities of the new Boxster and Cayman, the Panamera and Cayenne outsell them 10 to 1. The same is true for other premium brands – in contrast to previous norms their best selling models are often the most expensive – which in turn are purchased mostly by customers in either China or North America.

Lamborghini for instance sold 922 of their range-topping Aventador LP 700-4 in 2012, compared to 1,161 Gallardo models, but that’s before the recently launched Aventador LP 700-4 Roadster goes in sale in 2013. Bear in mind there are six models in the Gallardo range compared to just one Aventador, so it’s entirely possible that we’ll see the £240,000 Aventador becoming Lamborghini’s best selling model in 2013.

According to IHS Automotive, global sales of cars costing above 100,000 euros (£85,000) are set to exceed the 2007 peak sometime this year and grow 35 percent more by 2015 – to almost 540,000.

Much of this growth is fuelled by the US, who unlike Europe spent its way out of the downturn and is forecast to grow its new car market by 15 percent in 2013. According to Euromonitor International, the US is forecast to reach a wealthy household population (above $300,000 in annual income) of 4.6 million this year, which compares with just 1.3 million in China.

The demand is so strong in the US that Porsche, Ferrari, Maserati, Lamborghini, Aston Martin and Bentley are all banking on it for their success – with Lamborghini sales up 53% in the US, well ahead of Asia Pacific (including China) which grew by just 9%.

What does it mean?

After four years of economic uncertainty, some markets are booming, but building cars is still a resource-intensive business and plans must be firmed up at least 5-7 years ahead of time.

As nations exit this period of austerity, there is a tendency for those who are able, to ‘make up for lost time’. Supercars are just what the Doctor ordered – they provide a high-adrenaline hit that shows neighbours and colleagues that life (for you) is good, but it would be a mistake to view their current growth as a long-term trend, a sign that low-emission motoring is no longer a relevant market driver.

Renault may be out of step with current demand, but it’s range of efficient and characterful vehicles have yet to be tested in a healthy European economy. Brands like Toyota, Volkswagen and Ford will regain the limelight once more, but it might take a little longer than for BMW, Mercedes and Audi whose cars offer more in the way of those post-austerity rewards.

The importance of China

I remember doing business in China back in the late 90’s, when the opportunities seemed limitless – a country so rich in minerals and infrastructure, with a population four times the size of America is a huge catch. What’s not to like?

Well quite a lot actually. As many of my colleagues discovered, China has little interest in maintaining a balance of trade with other economies – you trade at your peril, but you WILL trade, because you can’t afford not to. We also learned that its population were, in the main, very poor and that most of its wealth was controlled by the Chinese government.

There are several challenges facing western car makers trading in China. While there’s certainly an appetite for exotic and premium vehicles, with demand for imports far outweighing that for home-grown varieties, there’s a severe lack of infrastructure to run them.

According to the Wall Street Journal, China’s deep environmental problems are now seen as an obstacle to its economic development. Heavy-duty trucks and buses account for around 61% of all vehicle pollutants and 80% of particulate matter, even though they account for just one-quarter of China’s vehicles.

Fuel quality is low, in part due to China’s oil refineries, but fuel companies cannot justify the investment due to the country’s heavily-regulated fuel pricing. So, with fuel quality well below that in the west, running a Lamborghini or Bentley outside of major cities such as Beijing or Shanghai can be a hazardous affair.

Ironically, while some see electric vehicles as the breakthrough solution, these draw their energy from China’s dirty coal-fired power stations, leading some to describe EVs as “coal burning cars.”

With poor quality fuel, emissions at a record level and a stand-off between government ministries and state-owned corporations on who fixes the infrastructure, it’s no wonder the US represents a market for supercar brands that is sixteen times more plentiful (per capita) than China.

Even mainstream car makers need to be mindful of China’s low income economy – with its absence of a middle-class and a complete lack of social welfare. Forbes.com recently wrote about China’s Gini coefficient — an index which measures social mobility and equality — which hit a low 0.474 last year, just slightly above the warning threshold set by the United Nations. Brands such as BMW and Mercedes are predominantly bought by middle-class workers, not billionaires, and without a prospering population of workers the business models of such companies just do not scale.

A recent survey by Bain & Co and China Merchants Bank found that 27% of entrepreneurs worth over US$16million had emigrated from China and 47% of those remaining are considering moving abroad – it would be ironic to find that investment in China was wasted, and that customers would come looking for western brands in their home markets.

What does it mean?

There’s a risk that too many car makers are counting upon the same opportunities in their business plans, without factoring in China’s own inherent problems and whether the targets they pursue will still be there after years of investment.

Unfortunately no car maker can afford not to trade in China, as it was in the 90s, China is a huge market even if the opportunities are sometimes overstated. But some brands are probably better off maintaining a shop window, rather than building infrastructure and centralising their resources.

While The West invests in China, Chinese investors are placing their bets in western brands. They’re also moving away from traditional labour-intensive products towards more valuable high-tech items.

China’s newest car maker Qoros, which is due to launch its GQ3 saloon at Geneva, is backed by an Israeli investor, led by experienced Europeans and is partnered with Microsoft, Continental and Bosch. They’re aiming at the premium sector, where quality wins out over price and targeting China’s biggest export market – Europe.

Analyze this..

When developing the strategy for a large global business, you spend much of your time spotting patterns, identifying the trends upon which key assumptions will be based and the discontinuities that require careful navigation. Only then can you start taking decisions about the resources to invest and the returns which can be expected.

There’s very little cause and effect analysis – it’s rarely that simple – but nevertheless you hope to find some strands of predictability, factors you can work towards without turning the plan on its head eighteen months later.

Perhaps the only certainty which luxury car makers will take comfort from is the US market. They know its customers, have already invested in the necessary infrastructure and can reap the rewards of a growing economy. China is a whole different can of worms, and I for one am thankful that my neck isn’t on the line for placing those bets.

No doubt, some European countries will stabilise during 2013 – Germany, UK, perhaps France, but the task of selling cars (profitably) is far from straightforward in 2013 and there’ll be plenty more to discuss besides the launches and press junkets.

p.s. If I wasn’t careful, this was heading towards being another 10,000 word article, so to save you (and me) from the tedium of that, feel free to ask any specific questions below. If I don’t know the answer, then I’m sure to know someone who does.

Disclosure: the author was formerly a partner at KPMG Consulting and Bain & Co.